Banks’ biggest fraud ever?

The Libor scandal is spreading to the United States. Will the Fed be a hero, or is it already a villain?

Topics: Finance, Ben Bernanke, Timothy Geithner,

Banks' biggest fraud ever?Timothy Geithner (right) and Ben Bernanke attend a meeting of the Financial Stability Oversight Council in Washington in April. (Credit: Reuters/Joshua roberts)

If rigging the world’s most important interest rates does not make you mad, just wait. The Libor scandal, which became public with Barclays Bank in London, is now spattering mud on at least three of America’s financial supermarkets – Bank of America, Citigroup and Jamie Dimon’s JPMorgan Chase – as well as on several European and other banks that have a major presence on Wall Street. Financial journalists are also digging into whether the Federal Reserve played cops or robbers in the affair, or more likely a bit of both.

Today, members of the Senate Banking Committee will ask Fed Chairman Ben Bernanke about the rigging and efforts to regulate it, and later this month they will put similar questions to Treasury Secretary Timothy Geithner. Before joining the Obama administration, Geithner served as president of the New York Federal Reserve and is now getting credit for knowing of the rigging as early as 2007 and trying to curb it in 2008, about the time Bear Stearns went to the wall. The oversight panel of the House Financial Services Committee is asking the two officials similar questions, as both try to reassure lawmakers and investors that they have the situation under control. They don’t, and it’s not all their fault. Too many nasty secrets have come out and too many cities, states, corporations, hedge funds and individuals will go to court around the world to try to recoup their losses, introducing enormous uncertainties. Though we are still in the early days of the public scandal, the rigging could well turn out to be what analyst Robert J. Shapiro  calls “the biggest financial fraud in history,” and the repercussions could in time prove even more toxic than the subprime mortgage crisis of 2007-08.

No one knows the true value of U.S. dollar- and British pound-denominated variable rate loans, mortgages, credit cards, credit default swaps and other derivatives that use the London interbank offered rate (Libor) to calculate their interest rates. Reputable media have published a wild range of estimates, while the generally authoritative Forbes and Wall Street Journal put the number as high as $800 trillion. Many more trillions in euro-priced instruments rely on a similar benchmark called Euribor, which the world’s leading banks – including Barclays, Citigroup and JPMorgan Chase – also appear to have gamed for their own profit. By comparison, the U.S. national debt is under $16 trillion.

You Might Also Like

Both Libor and Euribor depend on selected banks to give daily estimates of what they think they would have to pay for short-term interbank loans. The Barclays bankers initially inflated their estimates to earn more money on their loans, and then with the bankruptcy of Lehman Brothers and crash of the global financial system, lowered their estimates to make their banks seem a better credit risk than they were and to allow them to borrow money more cheaply. As now released emails from Barclay’s show, traders at the bank easily breached the so-called Chinese firewall between divisions to learn the true market rates and used the gap between them and Libor to make huge profits by shorting their bank’s stock or gambling on credit default swaps and other derivatives. Most of these Libor-based derivatives never traded on regulated exchanges with legally required transparency, making it difficult to know how many trillions of dollars’ worth have now become toxic. Hungry lawyers will seek to find out, while state and federal prosecutors, the Commodity Futures Trading Commission, the FBI and Scotland Yard try to figure out whether to press criminal charges for fraud and insider trading. If, as Forbes suggests, the banks actually colluded with each other to set the daily Libor, prosecutions would become more likely.

Markets will suffer from the size of the “cesspit,” as the Bank of England’s Paul Taylor called it, how long it percolates and how the spillover affects the solvency of the world’s leading financial institutions. Barclays has already agreed to pay $453 million in fines to U.S. and U.K. authorities, and three of its top officials are stepping down, including high-powered American CEO Bob Diamond. As savvy analysts are asking, will the other banks under investigation pay even heftier fines because Barclay’s was the first to cooperate with investigators? Will top execs also have to step down? And, I would add, what will all this do to the financial services industry and its ability to do what it’s supposed to do, which is to lend money to non-financial enterprises to produce real products that people need and want?

The scandal also raises troubling questions about what we have allowed to pass for regulation. The Federal Reserve is already boasting of how it learned of the rigging back in 2007 and instigated the investigation in 2008, which it did. But, as far as we now know, the Fed never told Barclays or any other bank on Wall Street to stop fudging its estimates. The reason is obvious. As the Wall Street Journal sagely observed, “We’d be surprised if any central bank officials in the U.S. or the U.K. weren’t privately encouraging lower rates during the crisis. They were already doing so publicly. Since the monetary authorities were attempting to manipulate interest rates of all kinds lower during the crisis, why would Libor be an exception?”

Worse, during the crisis, the Fed rewarded Barclays and the other banks involved with setting Libor rates by lending them hundreds of billions of dollars at knocked-down interest rates and without forcing them to change their behavior. The Fed and other regulators on both sides of the Atlantic also continued to allow Libor and Euribor to rely on what the bankers chose to tell them rather than on objective and transparent indicators. This may be about to change, as suggested by the settlement between Barclays and the Commodity Futures Trading Commission. But the badly misplaced trust in bankers seems inevitable as long as Jamie Dimon and other financial moguls sit on the boards of the Fed’s regional banks, a congressionally mandated indulgence that goes back to the original J. Pierpont Morgan and sorely needs to be eliminated.

Those who write the laws and regulations – like the senators and House members who will question Bernanke and Geithner – share in the blame. They have simply caved in to the bankers by allowing the derivative trade to operate in the dark where it continues to threaten the global economy with what Warren Buffet called “financial weapons of mass destruction.” But the real question is why civilized societies allow such instruments to be traded at all. Credit default swaps and other derivatives, ostensibly designed to help manage risk, have introduced overwhelming systemic risk, which we are fools for continuing to tolerate. Like other mythically free markets, those who trade in dangerous derivatives rely on courts to enforce their contracts. Without that enforcement, who would buy or sell their arcane offerings?

So, the next time the banks need taxpayer money, if not before, the solution is obvious: Use the leverage to criminalize the dangerous parts of the derivative trade or at least put them beyond the protection of our legal systems, as we do with contracts to sell atomic bombs, human beings or body parts. It’s just a modest proposal, but one that the United States and other major countries should begin to consider.

More Related Stories

Featured Slide Shows

  • Share on Twitter
  • Share on Facebook
  • 1 of 11
  • Close
  • Fullscreen
  • Thumbnails
    Martyna Blaszczyk/National Geographic Traveler Photo Contest

    National Geographic Traveler Photo Contest Entries

    Slide 1

    Pond de l'Archeveche - hundreds thousands of padlocks locked to a bridge by random couples, as a symbol of their eternal love. After another iconic Pont des Arts bridge was cleared of the padlocks in 2010 (as a safety measure), people started to place their love symbols on this one. Today both of the bridges are full of love locks again.

    Anders Andersson/National Geographic Traveler Photo Contest

    National Geographic Traveler Photo Contest Entries

    Slide 2

    A bird's view of tulip fields near Voorhout in the Netherlands, photographed with a drone in April 2015.

    Aashit Desai/National Geographic Traveler Photo Contest

    National Geographic Traveler Photo Contest Entries

    Slide 3

    Angalamman Festival is celebrated every year in a small town called Kaveripattinam in Tamil Nadu. Devotees, numbering in tens of thousands, converge in this town the day after Maha Shivratri to worship the deity Angalamman, meaning 'The Guardian God'. During the festival some of the worshippers paint their faces that personifies Goddess Kali. Other indulge in the ritual of piercing iron rods throughout their cheeks.

    Allan Gichigi/National Geographic Traveler Photo Contest

    National Geographic Traveler Photo Contest Entries

    Slide 4

    Kit Mikai is a natural rock formation about 40m high found in Western Kenya. She goes up the rocks regularly to meditate. Kit Mikai, Kenya

    Chris Ludlow/National Geographic Traveler Photo Contest

    National Geographic Traveler Photo Contest Entries

    Slide 5

    On a weekend trip to buffalo from Toronto we made a pit stop at Niagara Falls on the Canadian side. I took this shot with my nexus 5 smartphone. I was randomly shooting the falls themselves from different viewpoints when I happened to get a pretty lucky and interesting shot of this lone seagull on patrol over the falls. I didn't even realize I had captured it in the shot until I went back through the photos a few days later

    Jassen T./National Geographic Traveler Photo Contest

    National Geographic Traveler Photo Contest Entries

    Slide 6

    Incredibly beautiful and extremely remote. Koehn Lake, Mojave Desert, California. Aerial Image.

    Howard Singleton/National Geographic Traveler Photo Contest

    National Geographic Traveler Photo Contest Entries

    Slide 7

    Lucky timing! The oxpecker was originally sitting on hippo's head. I could see the hippo was going into a huge yawn (threat display?) and the oxpecker had to vacate it's perch. When I snapped the pic, the oxpecker appeared on the verge of being inhaled and was perfectly positioned between the massive gaping jaws of the hippo. The oxpecker also appears to be screeching in terror and back-pedaling to avoid being a snack!

    Abrar Mohsin/National Geographic Traveler Photo Contest

    National Geographic Traveler Photo Contest Entries

    Slide 8

    The Yetis of Nepal - The Aghoris as they are called are marked by colorful body paint and clothes

    Madeline Crowley/National Geographic Traveler Photo Contest

    National Geographic Traveler Photo Contest Entries

    Slide 9

    Taken from a zodiac raft on a painfully cold, rainy day

    Ian Bird/National Geographic Traveler Photo Contest

    National Geographic Traveler Photo Contest Entries

    Slide 10

    This wave is situated right near the CBD of Sydney. Some describe it as the most dangerous wave in Australia, due to it breaking on barnacle covered rocks only a few feet deep and only ten metres from the cliff face. If you fall off you could find yourself in a life and death situation. This photo was taken 300 feet directly above the wave from a helicopter, just as the surfer is pulling into the lip of the barrel.

  • Recent Slide Shows



Comment Preview

Your name will appear as username ( settings | log out )

You may use these HTML tags and attributes: <a href=""> <b> <em> <strong> <i> <blockquote>